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In this response we have focussed most of our comments on issues arising out of Article 3, relating to trading book exposures.
In general, we are very concerned about the proposals to require use of the standardised method to decompose the IRC across geographies. We believe that this proposal will lead to an inaccurate identification of geographical locations. IRC is not driven by or correlates well with the standardised capital charges, so geographies that might show up as being significant under the standardised method may not be a strong contributor to the IRC. This mis-apportionment across geographies would be distortive and could penalise jurisdictions that are not the target of countercyclical buffers (CCBs). Ultimately this could thwart the macroprudential objectives of the CCB.
Further, requiring use of the standardised method will create an unnecessary administrative burden for firms that do not use the standardised method, but for no benefit. This administrative burden will place a sizable obligation on such firms – a burden that does not seem to be reflected in the RTS’s impact assessment.
As general principles we believe that (a) identification of geographical locations should be reasonably accurate, to avoid distortions, and (b) that the burden of implementing any approach should be balanced against the incremental benefits.

We do not believe the proposals meet these standards. We strongly encourage the EBA to take more time to consider the options for implementing this requirement and, in doing so, to undertake a dialogue with industry to find an appropriate solution. The phasing in of the countercyclical buffer does not begin until 1 January 2016. Even allowing for system build in advance of that date we believe more time is available to consider the issues, including if necessary a second round of consultation based on refined proposals by EBA. We would support the EBA seeking agreement from the Commission for an extension of the 1 January 2014 deadline for submission of this RTS to facilitate a more fulsome consideration of the issues.

We have set out in the uploaded document two potential alternative approaches to determine the location of trading book exposures which we believe warrant further consideration by the EBA. Due to the inherent complexities in IRC models, we would welcome further engagement with the EBA on this in particular taking into account the objectives of the CCB.

We believe the treatment of counterparty credit risk (CCR) needs more consideration. At present it appears to be treated together with credit risk exposures under Article 2. We are not convinced that for CCR this is necessarily appropriate. Banks do not tend to consider their underlying risk as relating to the location of the obligor. Rather, a more nuanced approach is taken, including consideration of the geographical location referenced by the underlying instrument, for example. Thus, an unrefined treatment of CCR could lead to inappropriate allocations and further consideration of the approach for CCR is appropriate.
While the location of the obligor may be appropriate for retail exposures, we believe that a more nuanced approach may be appropriate for many non-retail credit exposures. Banks should have the option to take account of wider circumstances, including credit risk mitigation, to determine the location of such exposures if they believe this will result in a more accurate identification and it is more in line with their risk management approach. As a protection from ‘gaming’ between the different approaches firms could be required to have the approval of their supervisor for any change in approach for either all of their credit exposures or for specific portfolios.
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With respect to the materiality threshold for credit exposures in Article 2(4), we note that a similar but differently-calibrated threshold is being used for the purposes of COREP (Article 5 of EBA-ITS-2013-02), where information on geographical location is not required unless original ‘non-domestic’ exposures are greater than 10% of total original exposures. We believe that consideration should be given to increasing the materiality threshold in this RTS to align with that in the COREP ITS.
Please see the detailed comments in the uploaded document.
We believe that the materiality threshold set in Article 3(4), of 2%, is too low. At that level the maximum error in the calculation of the CCB for trading book exposures would be 5 basis points (2% multiplied by 2.5% maximum CCB). Given that trading book exposures included in the CCB calculation only represent a portion of total exposures (including credit and securitisation exposures also), and that error will only arise to the extent that trading book exposures are differently distributed to credit and securitisation exposures, this expected potential error is even lower. We believe that a materiality threshold of 10% would still represent an acceptable level of potential error, but provide a more proportionate approach for firms with relatively small trading book exposures. Given the general relative sizes of credit and trading books, a 10% threshold for trading book exposures would be appropriately equivalent in absolute magnitude to the 2% materiality threshold for foreign credit exposures in Article 2(4).

Article 3(4) of the RTS defines the materiality threshold by the relative size of “total trading book risk-weighted exposures”. We believe, in the context of the RTS, it should be clarified that the reference to ‘total trading book risk-weighted exposures’ in fact relates to ‘own funds requirements for specific risk in the trading book or incremental default and migration risk’. As a general point it is important that references such as this are very precise in the RTS.

To be clear, the materiality threshold should be ‘optional’ for firms, who should be able to opt to determine locations for trading book exposures if they wish. They may wish to do so when their trading book exposure locations are significantly different from their other exposures, leading to an error in the calculation of their CCB.
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In general, we are very concerned about the proposals to require use of the standardised method to decompose the IRC across geographies. We believe that this proposal will lead to an inaccurate identification of geographical locations. IRC is not driven by or correlates well with the standardised capital charges, so geographies that might show up as being significant under the standardised method may not be a strong contributor to the IRC. This mis-apportionment across geographies would be distortive and could penalise jurisdictions that are not the target of countercyclical buffers (CCBs). Ultimately this could thwart the macroprudential objectives of the CCB.

Further, requiring use of the standardised method will create an unnecessary administrative burden for firms that do not use the standardised method, but for no benefit. This administrative burden will place a sizable obligation on such firms – a burden that does not seem to be reflected in the RTS’s impact assessment.
As general principles we believe that (a) identification of geographical locations should be reasonably accurate, to avoid distortions, and (b) that the burden of implementing any approach should be balanced against the incremental benefits.

We do not believe the proposals meet these standards.
Michael Percival
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